0x Explained – 0x USD (Cryptocurrency:ZRX-USD)

Introduction

0x (ZRX-USD) is an ERC-20 token designed to facilitate the adoption of a protocol that could add liquidity to decentralized exchanges (Dexs if you prefer). 0x is not to be confused with district0x (DNT-USD), which is also an Ethereum (ETH-USD) ERC-20 token.

The ZRX token is limited to the Ethereum network, as is operates on the Ethereum blockchain and at this time only facilitates the exchange of ERC-20 tokens. Therefore, its success will rely on Ethereum’s success, but if Ethereum succeeds, it does not necessarily follow that 0x will too.

Why now?

Back in May of 2018, Coinbase (COINB) acquired Paradex. Paradex was a decentralized exchange that was building on top of (or at least including the technology in) the 0x protocol.

When tokens get listed on Coinbase, it’s a big deal. There’s a lot of work that goes into making sure the platform is stable, and coins have to meet certain criteria before Coinbase will list them. It’s not a full endorsement, but this vote of confidence does usually cause a wave of money to flood in.

We saw this when Litecoin (LTC-USD) and Ethereum Classic (ETC-USD) were listed as well. Coinbase announced they were adding support for Litecoin on May 3rd, 2017. Look how the market responded.

Because of this huge market reaction, there’s a lot of money to be made if you can figure out which token will be listed next.

Coinbase has published their criteria for listing new assets, which includes requirements that the asset is not controlled by a single entity, that it meets certain security considerations, and the list goes on. You can read it in detail here.

Since the only other token on this list that’s an ERC-20 token is BAT, I can’t help but speculate that Basic Attention Token might be their next choice; but, we can’t be certain of this.

What problem is 0x trying to solve?

You can use a centralized exchange, or a decentralized exchange; but they both have issues. Centralized exchanges get hacked all the time, and decentralized exchanges are usually highly illiquid and a total PITA to use.

0x is a protocol for transmitting orders in such a way that many exchanges can listen for maker orders, and add them to their books. In other words, if five exchanges today all have 1,000 orders on their books, you could build a system on 0x that had 5,000 orders on each exchange, because liquidity pools are shared.

Whitepaper

Compared to a lot of other whitepapers, this one does a good job of controlling their scope. I get spooked when I read a whitepaper and the founders start rattling on about global domination, AI, DAOs, and all sorts of things that are each a universe in and of themselves.

Here we have a clearly defined scope, purpose, and approach. Everything they want to do can be done today, and it’s fairly easy to understand. So far, so good.

Last time I checked, the majority of the top 100 cryptos were ERC-20, so even though it does seem like a limitation; they’re still talking about a lot of different projects and the set is growing constantly. So, the growth of the Ethereum network would be considered a positive externality, but also a prerequisite.

In their introduction they get right to the point. The blockchain was about being able to exchange things digitally without a middleman. Using a centralized exchange defeats this purpose in many ways.

Blockchains have been revolutionary by allowing anyone to own and transfer assets across an open financial network without the need for a trusted third party. Now that there are hundreds [1] of blockchain based assets, and more being added every month, the need to exchange these assets is compounding. With the advent of smart contracts, it is possible for two or more parties to exchange blockchain assets without the need for a trusted third party.

They continue:

Decentralized exchange is an important progression from the ecosystem of centralized exchanges for a few key reasons: decentralized exchanges can provide stronger security guarantees to end users since there is no longer a central party which can be hacked, run away with customer funds or be subjected to government regulations. Hacks of Mt. Gox, Shapeshift and Bitfinex [2, 3] have demonstrated that these types of systemic risks are palpable. Decentralized exchange will eliminate these risks by allowing users to transact trustlessly – without a middleman – and by placing the burden of security onto individual users rather than onto a single custodian. – 0x Whitepaper

The Rise of the DEX

If you’re not trading cryptos in the wild, you may have never used a DEX (decentralized exchange). If that’s the case, then you probably don’t realize that there’s a ton of them, and they’re mostly terrible in terms of liquidity and user-friendliness.

Nevertheless, taken in aggregate are improving over time and becoming increasingly popular. You can see a number of these exchanges ranked by usage here.

Because of the state of the cryptocurrency market at large, it’s not always easy to tell when an idea is gaining traction, an idea like the DEX for example. But, we have to realize that progress is always very slow at first, but it does accumulate over time.

The ZRX token use case

All this so far is fine and dandy, but why is the ZRX token needed? This is an important thing to think about. Decentralized applications have existed for a long time without tokens, such as BitTorrent. So, why do we need a token?

Well, even decentralized platforms need some kind of incentive structure. Before the ICO mania you could either ask for donations, implant ads, or just hope people took the idea and ran with it. But, with a token there’s a way to incentivize participants (coders, third parties, users).

Again, from the whitepaper:

Cryptoeconomic protocols create financial incentives that drive a network of rational economic agents to coordinate their behavior towards the completion of a process [4, 17, 18]. While 0x is fundamentally a network protocol used to facilitate signalling between buyers and sellers (rather than a cryptoeconomic protocol), it is intended to serve as an open standard for dApps that incorporate exchange functionality. Establishing and maintaining an open standard is a coordination problem that adds operational overhead for all contributing parties; coordination can be especially challenging when each party has different needs and financial incentives. Protocol tokens can align financial incentives and offset costs associated with organizing multiple parties around a single technical standard. While aligning incentives around adoption is useful, protocol tokens can be used to address a much more challenging issue: future-proofing a protocol implemented within an immutable system of smart contracts via decentralized governance. – 0x Whitepaper

Governance is hard, let’s just put that out there. If you don’t have some way for people to express their desires, a platform can get out of touch with its user base over time. Giving token holders the ability to vote with their tokens allows the protocol to stay relevant.

Also, with a war chest it becomes much easier to get a project off the ground. I think if someone has a good idea they should make something for their efforts. Since participation in this system is voluntary, why not?

Risk management

As with other ERC-20 tokens, investors should be aware that if Ethereum suffers downtime, or sees usage grow faster than its scaling solutions, there will be negative implications for 0x.

There are many tokens running on the Ethereum blockchain already, and when the market is in an upswing they must compete for space on the blockchain. This competition leads to increased fees, which can eventually push users to other platforms.

With this in mind, I recommend limiting exposure to this asset to a fraction of what you’re willing to invest in Ethereum itself. After all, if Ethereum were to outright fail, 0x would be in dire straits.

Conclusion

It’s ironic that a token for building decentralized exchanges is now listed on Coinbase, which is a centralized exchange. However, this move is the first time that an ERC-20 token has been listed on Coinbase. If this move is a success, we could see many more tokens of this kind follow suit.

In this regard, 0x may serve as the linchpin of the ERC-20 movement on Coinbase, or as a terrible counterexample if things don’t go well. That being said, I am cautiously optimistic about the 0x project.

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Disclosure:I am/we are long BTC-USD, ETH-USD.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.